Back in the 1980’s and 1990’s and even into the beginning of this century, student loan bonds were issued with great regularity and in a large dollar volume. Then a single event in 2010 (described below) dramatically diminished the issuance of new money student loan bonds. Given that diminished flow of student loan financings, why would the IRS bother to issue a private letter ruling (PLR 201447023) on November 21, 2014?
What are Student Loan Bonds? The Higher Education Act of 1965 allowed private sector banks and special entities like Sallie Mae to originate federally guaranteed student loans the interest rate on which was also subsidized by the federal government. If a student needed to borrow money to go to college, that student could go to the bank and take out a student loan. If the loan was properly structured and documented, the holder of the loan would receive a federally subsidized interest rate while the student would pay an affordable rate. The banks could then package the loans and sell them to state or local governmental agencies who are authorized to purchase the loans with the proceeds of tax-exempt bonds (Federal Program Student Loan Bonds) issued under Section 144(b)(1)(A) of the Code. The state and local student loan bond issuing authorities were making a secondary market in these loans which helped make them more economical for the banks (due to the liquidity provided) and therefore more affordable for students. The Federal Program Student Loan Bonds were payable from the federally guaranteed student repayments of their loans. Billions of dollars of such Federal Program Student Loan Bonds were issued.
Section 144(b)(1)(B) of the Code similarly allows state and local student loan authorities to issue bonds the proceeds of which are used to purchase certain supplemental student loans originated under a state program (State Program Student Loan Bonds). The dollar volume of the state program loans was significantly less than the dollar volume of the federal program loans and so the volume of State Program Student Loan Bonds was significantly less than the volume of Federal Program Student Loan Bonds.
What happened to Student Loan Bonds? In 1994, the US Department of Education (USDOE) also started making federally guaranteed loans directly to students through colleges and universities without the involvement of the private sector. By 2006, about 20% of the student loans were originated by the USDOE and the remaining 80% were originated by the private sector. When the credit crisis hit in 2008, the balance started to tilt more heavily toward USDOE loans and away from private loans. By 2009 the direct USDOE program had grown to 35% of all federally guaranteed loan originations while the private sector shrunk.
Then, on July 1, 2010, a new law, which was actually contained within a health care bill, became effective. That law reversed the Higher Education Act of 1965 approach to federally guaranteed student loans originated by the private sector and turned over all student loan originations to USDOE. Accordingly, the secondary market for federally guaranteed student loans was changed dramatically (since banks no longer needed the same level of liquidity) and, as a result, the volume of new money financings of student loans dropped significantly.
Are Student Loan Bonds Still Issued? There are still three types of student loan bonds being issued. First, state and local student loan authorities are permitted to issue bonds to refinance Federal Program Student Loan Bond to achieve savings or to restructure the debt. Second, the Code also allows state and local student loan authorities to issue State Program Student Loan Bonds, which are not federally guaranteed, and thus were not affected by the change in law in 2010. Third, there are also bonds issued to refinance State Program Student Loan Bonds.
What does PLR 201447023 Cover? PLR 2014047023 deals with bonds to be issued to refinance State Program Student Loan Bonds. The ruling deals specifically with a student loan authority that will issue bonds to finance loans that will allow a student loan borrower to consolidate his or her multiple outstanding student loans into a single loan (Consolidation Loans) and allow the borrower to obtain the benefit of the cost savings that come along with processing a single loan instead of processing multiple loans. The ruling permits the State Program Student Loan Bonds to be issued on a tax-exempt basis for this purpose.
To obtain this favorable treatment, the ruling requires that several critical elements be present:
- The original loans being refinanced were originally financed with the proceeds of State Program Student Loan Bonds.
- The original loans now being refinanced on a consolidated basis all previously met the “nexus” test for the state program under Section 144(b)(1)(B), which means that the student borrower at the time the refinanced loan was originated was either a resident of that state from which the volume cap was derived or attended an institution of higher education in that state. The IRS recognized that it is possible that some of the student borrowers who had that nexus at the time of the original loans may no longer be residents of that state or attending a higher educational institution in that state.
- The tax-exempt bonds that financed the original loans were all given the requisite amount of volume cap from that state as required by Section 146 of the Code. Under Section 146 of the Code, new volume cap is not needed for a refunding issue if (i) the amount of the refunding bonds does not exceed the outstanding amount of the refunded bonds and (ii) the maturity date of the refunding bonds is not later than the average life of the refunded bonds and in no case later than 17 years after the original bonds were issued.
- The amount of the Consolidated Loan for each student borrower does not exceed the sum of the outstanding amounts of each loan for that student borrower plus any interest capitalized to or accrued interest on those original loans. The ruling does not explain what it means by “interest capitalized to” the original loans. However, paying interest on a refunded obligation is considered a permissible refunding purpose in the definition of a refunding found in Treas. Reg. §1.150-1(d)(1) . The ability to finance interest capitalized to the original loans may not be relevant if the amount of the State Program Student Loan Bonds is restricted to the outstanding amount of the bonds that financed the original loans unless additional volume cap is obtained. The ruling does not make it clear whether any bonds issued with additional volume cap from the original nexus state to pay any excess amounts beyond the outstanding principal of the refunded bonds would be appropriate, although following the “stepping in the shoes” of the refunded bonds rationale (as described below), that would appear to be the correct approach.The original loans were not federally guaranteed loans described in Section 144(b)(1)(A) of the Code.
- While all private letter rulings are very fact specific and addressed only to the recipient, the ruling is generally helpful. It makes it clear that the IRS will allow issuers to issue tax-exempt bonds to provide funds to acquire Consolidation Loans under the terms set forth in the ruling. Also, the ruling allows a refinancing of State Program Student Loan Bonds on a tax-exempt basis as long as the nexus requirement was met at the time the original loans were financed on a “step in the shoes” basis. In support of this conclusion, the ruling cites Treas. Reg §1.103-7(d)(1), which first espoused this concept in 1972, by stating “ . . . the proceeds of the refunding issue will be considered to be used for the purpose for which the proceeds of the issue to be refunded were used.” As such, the ruling appears to uphold the “common law right to refund” also embodied in Prop. Reg. 1.103-7(e) (later withdrawn).
The ruling restricts itself to the subject matter of Section 144(b)(1)(B) of the Code and does not undertake any analysis of the arbitrage rules in Section 148 of the Code that govern yield compliance for student loan bonds. However, the ruling does make a passing reference to Section 148 of the Code in reciting the law governing student loan bonds and the Ruling also references the portion of the applicable arbitrage regulations (Treas. Reg. §1.148-9) governing the transfer of proceeds from the refunded bonds to the refunding bonds and the allocation of investments corresponding to those transferred proceeds. But the analysis section of the ruling never mentions the arbitrage rules.
Even though the supply of Student Loan Bonds has diminished, the IRS recognized in the ruling that there are still State Program Student Loan Bonds that can be issued for new loan originations and to refinance loans on a consolidated, more cost efficient basis. The IRS provided helpful guidance to facilitate an understanding of the parameters under which those State Program Student Loan Bonds may be issued.